Fannie and Freddie: More Defaults to Come (John Hempton's "Modelling Fannie Mae and Freddie Mac – part IV") FNM; FRE

Here's the summary, shareholders would be well advise to read the whole thing.

...Summary of Part IV

In this post I show how using naïve (but surprisingly robust) models using data in the cumulative default curves you can get estimates of the end losses of both Fannie and Freddie.

Using these models I show that the end losses in the traditional guarantee book of business are very close to the reserves currently embedded in Freddie Mac’s accounts. [The same applies at Fannie Mae too.]

This argues strongly against the notion that Fannie Mae and Freddie Mac will be substantial ongoing drains on the Federal budget. It also argues fairly strongly against the notion that the quasi-government GSEs cost taxpayers more than the private sector companies that they competed with. AIG – who led the FM Watch – an anti-Fannie-and-Freddie lobby group will wind up costing taxpayers considerably more than the GSEs.

Moreover the losses on the GSE’s core business (the losses modelled in this post) look like they are about the same as the original GSE capital base. If the GSEs had not (foolishly) purchased private label mortgage securities (the losses detailed in Part II) then the cost to the taxpayer would have been negligible.

This has big implications for the reform of GSEs – something supposedly under discussion at the NEC – and also of concern to many. The traditional guarantee business of the GSEs simply did not perform that badly during the worst mortgage crisis in modern finance. That should be borne in mind by the GSE critics.

As to what the end cost to the government will be – and whether there is any residual value in the remaining Fannie and Freddie securities – that is the subject of a future post in this sequence.